By Doug Fabian
Since May 22, the only story that really matters to the markets is what the Federal Reserve is going to do with respect to its current bond-buying program. On that day, we heard Chairman Ben Bernanke introduce the concept of “tapering” into the trading milieu. Since then, stocks have sold off hard, and bonds have sold off really hard.
Bond yields, which move the opposite of bond prices, have soared. From May 22 through June 18, the yield on the 10-year Treasury note spiked 12.2% to a level we haven’t seen since April 2012. Immediately following today’s dovish Fed statement, which had no hint of any pending tapering anytime soon, the yield on the 10-Year note yield index spiked some 6.5% to more than 2.30% (as of 3 p.m. EDT).
The language in today’s Fed statement was the biggest reason for the spike in bond yields. Here was the key quote from the FOMC statement: “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.” The Fed also raised its expectations for Gross Domestic Product (GDP) growth for 2014, from 2.9-3.4% to 3-3.5%.
Now, while I don’t think this GDP growth rate is very strong, it seems to be enough for bond traders, and hence the selling in bonds, as represented by the chart here of the iShares 20+ Year Treasury Bond ETF (TLT).
Interestingly, during Ben Bernanke’s press conference, stocks also fell hard, with the Dow dropping some 142 points, or 0.93%, as of 3 p.m. EDT.
So, even though the Fed came out with a dovish position on monetary policy, it seems like both the stock and bond markets are skeptical.
If you own either stocks or bonds here, then I highly recommend that you exercise the utmost caution and reduce your exposure to the riskiest asset classes out there. For stocks, it could mean selling some of your winners and increasing your cash position. For bonds, it means reducing your exposure to high-yield sectors such as junk bonds. Perhaps more importantly, it also means reducing your exposure to bonds with the longest-dated maturities, as they pose the greatest interest-rate risk.
Now is the time to start taking action, as you don’t want to get caught up in a Fed-induced selling reaction in either stocks or bonds.
On the Limits of the Fed
“Monetary policy cannot do much about long-run growth; all we can try to do is to try to smooth out periods where the economy is depressed because of lack of demand.” --Ben Bernanke
It seems as though even the Fed chairman realizes the central bank is limited in its ability to help the economy in the long run. Still, the Fed will pull the levers the way it sees fit, and that is a reality we’ll all have to deal with for years to come.
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